This Mega-Deal Is Priced to Yield 7.5%

"Unforgettable, that's what you are ..."
-- Nat King Cole

Cole Real Estate Investments (NYSE: COLE  ) had just became a publicly traded REIT this past June. Rival and suitor American Realty Capital Properties (NASDAQ: ARCP  ) already attempted a takeover of Cole prior to its recent IPO.

Not long after that takeover attempt, American Realty Capital Properties announced acquisitions totaling more than $3 billion: a merger with CapLease, Inc, and acquiring assets from GE Capital. Then, ARCP bought American Realty Capital Trust IV for $3.1 billion this past July. American Realty Capital Properties had plenty on its plate to digest.

It appeared that everybody moved on... except, Cole was evidently unforgettable, and thought that American Realty Capital Properties was unforgettable, too.  

The deal
On an Oct. 23, 2013 joint conference call, American Realty Capital Properties announced an agreement to buy Cole for a reported $6.85 billion, plus assumed debt, that values the deal at $11.2 billion.

Source: ARCP

The board of directors of both companies voted unanimously in favor of combining the two REITs, which will have an estimated enterprise value of $21.5 billion. This would exceed the value of longtime triple net leader Realty Income (NYSE: O  ) by more than 60%.

American Realty Capital Properties CEO Nick Schorsch made it clear during the conference call that he expects the market to reward the merged company with better AFFO multiples, consistent with being the $21.5 billion "category killer" in the triple net sector.

Source: ARCP

This would result in a higher American Realty Capital Properties stock valuation, which would help to make acquisitions accretive to earnings moving forward. The merged company expects to acquire $2 billion of new net lease assets during 2014 as part of its "organic growth."

Buying Cole has many advantages

  • American Realty will reduce its net debt to EBITDA ratio from 9.1x to 7.7x by the end of 2014.
  • A more diversified portfolio of assets that is 99% occupied, with 11 years remaining average lease term.
  • Anticipate a lower cost of capital being accretive to earnings due to Moody's awarding American Realty with a Baa3 investment grade one week prior to the Cole merger announcement.
  • American Realty will no longer be competing with Cole's private capital management group.

In fact, American Realty plans to utilize the Cole brand, broker-dealer and financial advisor relationships, and a team of experienced Cole employees, as an ongoing source of fee income, as well as a net lease acquisition pipeline.

Dividend of the month club

ARCP Dividend Yield (TTM) Chart

Industry stalwart Realty Income is also known as "The Monthly Dividend Company."  American Realty pays out its dividends on a monthly basis, as well. Retirees and other investors looking to augment their monthly incomes often rely on REIT dividends.

"When the deal is complete the company would pay a 7.5% dividend yield, more than double the 3.3% average of the top 15 public REITs," Cole CEO Marc Nemer stated on the conference call.

The tortoise and the hare
Realty Income has been the gold standard in the triple net lease sector.  It leases to a diverse group of mainly credit tenants, and has a 98% occupancy rate. S&P recently upgraded Realty Income's investment bond rating to BBB+, reflecting the lower risk profile of this more-seasoned company.

Realty Income has built its portfolio of net lease assets slowly and carefully over time.

American Realty has only been a publicly traded REIT since 2011. They are in the process of internalizing management while they are acquiring and integrating multiple acquisitions at a frantic pace. I think that Mr. Market will take some time to see how things work out prior to anointing American Realty as the "category killer" in the net lease sector. There are a lot of moving parts to nail down during the next six months.

Investor takeaway
Cole shareholders have the option of receiving stock or cash (up to an aggregate limit of 20% of the purchase price). The triple net business is not rocket science. However, integrating several corporate cultures -- while trying to hire a new senior management team -- might not be a walk in the park.

Investors know what they have with Realty Income, and I think that is worth a premium right now. American Realty has to execute and prove to Wall Street it is worth a premium valuation. However, a 7.5% yield, and the potential stock appreciation that it implies, might be just the right tune for many investors. Regardless, this deal is truly unforgettable.

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